| BUSINESSWEEK ONLINE : DECEMBER 13, 1999 ISSUE | ||||||||
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| BUSINESSWEEK INVESTOR
Commentary: The Drawbacks of Stock-Option Fever If some stock options are good, a ton must be great, right? That appears to be the prevailing wisdom in options-happy Corporate America these days. But new research makes you wonder if the options revolution is beginning to leave investors in the lurch. The main finding is that heavy use of options doesn't accomplish its stated mission: to align the interests of managers and other employees with those of shareholders. In fact, heavy use of stock options seems to make top execs adopt overly risky strategies, some studies suggest. And fluctuations in the value of options can make lower-level employees feel as if their compensation is unrelated to their performance. Defenders of options say their risk-engendering nature is a good thing for well-diversified shareholders, who should be happy if managers of companies they own go out on a limb in pursuit of big rewards. But incentives to take risks can get out of hand, and there's increasing evidence that many companies are at that point. One way to tell who's overdoing options is to look at a company's performance. That's what Gerry Sanders, a professor at Marriott School of Business at Brigham Young University, did. He started with the idea that there are two main ways to motivate executives: pay them for proven performance by making a large portion of their compensation contingent on how well they did their jobs over the past year, or focus on the future by giving them options, figuring they'll work to push up the company's stock price to make their options more valuable. In an unpublished study, Sanders found that overall compensation was highest--and performance the worst--among companies that grant lots of options and don't tie cash compensation closely to past performance. General Motors (GM), Kellogg (K), and Digital Equipment were among them. The best performance came from companies whose CEOs got relatively few options and had lots of their cash compensation tied to past success. Examples: supermarket chain Kroger (KR) and hardware chain Lowe's (LOW). RECKLESS? Option compensation may also be leading to more corporate mergers, some of them unwise. In another unpublished study, Sanders found that CEOs who hold many options, especially ones that are ''out of the money,'' or not worth exercising at the current stock price, are more likely to make acquisitions. His theory: A CEO with out-of-the-money options will be rewarded if an acquisition bet pays off and his stock soars above his options' exercise price. If the acquisition fails and the stock crashes, so what? The options were nearly worthless anyway. Ira Kay, practice director of the human-capital group at compensation consultant Watson Wyatt Worldwide, analyzed 20 companies identified in a landmark 1988 Securities & Exchange Commission study as either very good or very bad at acquisitions, based on whether their stocks tended to rise or fall on a purchase announcement. Kay won't name names, but he found that the executive pay of the worst acquirers was five times more reliant on stock options, vs. stock ownership, than the pay of the best. Options are even less suitable for employees outside the executive suite. Their options can go up when they're doing a bad job--and flop when they excel. Such randomness is demotivating. And the problem gets worse as more people get options. Watson Wyatt found that about 19% of all employees were eligible for options this year, up from 12% in 1998. Kay says compensation committees like options in part because they don't depress reported earnings. But if options don't motivate execs and lower-level employees to do the right thing for shareholders, what's the point? By PETER COY _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP |
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